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Highlights
When detected in a strongly trending market, flag patterns can be potential indicators that traders use to go long or short.
Bullish and bearish flags are continuation patterns commonly used in trading that consist of three main components: the mast, the flag, and the resistance breakout point.
Traders can use these flags along with other indicators, such as the Relative Strength Index (RSI), to gauge how overbought or oversold an asset may be.
Identifying trends early when trading digital assets allows traders to plan and execute their trades effectively. Chart patterns are an essential tool that many technical analysts use to attempt to predict future digital asset movements and recognize key patterns.
Traders typically turn to bullish and bearish chart patterns to try to determine whether a price trend will extend or reverse. Among these chart patterns, flags are quite popular in technical analysis as they can provide valuable information about price trends and possible future movements.
Flag patterns formed by lines and shapes drawn on price charts are potentially useful for identifying upcoming trends, resistance breakouts, and reversals. This article explores two types of flag patterns: bullish and bearish flags; It also provides information on how some traders use them.
What are bullish flags and bearish flags?
Bullish and bearish flags are among the most popular continuation patterns. They generally appear when the trend is likely to continue to prevail.
Bullish flags typically appear in an uptrend when the price trend is expected to continue rising. Bearish flags are often observed during a downtrend when it is anticipated that the price of an asset will face more downward pressure.
Each flag pattern consists of two main components: the flagpole and the flag. The mast represents a significant major or minor movement, depending on whether it is a bullish or bearish flag. Typically, the creation of a flagpole is accompanied by a considerable increase in trading volume.
Following the formation of the flagpole comes the consolidation phase. This looks like an ascending or descending parallel channel and creates the flag of the chart pattern.
For bullish flags, the flagpole precedes the flag, while for bearish flags, the flag forms before the flagpole.
How to use a bull flag pattern for trading
A flag pattern can be an informative chart pattern that some traders use in order to analyze possible breakout points of price resistance to enter or exit trades. The chart pattern can also be used to try to calculate how much the price can rise or fall. Price action for bullish and bearish flags usually reflects the distance from the mast following a resistance breakout or sharp reversal.
First, traders tend to identify an uptrend that has begun to consolidate. During the consolidation phase, the price will form a rectangular figure with a resistance line as the upper limit and, in parallel, a support line as the lower limit.
Once the flag pattern is identified, traders will locate the entry point. The resistance breakout point is located where the candle extends above the upper boundary of the flag, and this area functions as the entry point for buyers. The target of the bull flag is the percentage increase in the height of the mast that adds to the resistance breakout point.
To minimize potential losses, some traders may also create a stop-loss order at the base of the flag, the low point of the consolidation phase. This will limit potential losses if the price moves against the trade.
Some traders may use the height of the flagpole to set a profit target. To determine the profit target, traders should measure the height of the flagpole from the bottom to the top, and then add it to the resistance breakout price.
How to use a bearish flag pattern for trading
To determine the entry point for sellers in a bearish flag pattern, the height of the mast is subtracted from the resistance breakout price. This occurs when the price of the asset extends below the lower boundary of the flag.
To limit potential losses, some traders may open a stop-loss order at the swing high of the flag, which is the highest point of the consolidation phase, in case the asset moves in the opposite direction.
To calculate the height of the mast, traders must subtract the lowest point of the mast from the highest point. Ideally, the consolidation phase for both bullish and bearish flags should not exceed 50% of the flagpole. A reversal phase greater than 50% may indicate that the trend does not have the necessary strength.
Additionally, the reversal phase typically represents 38.2% of the swing high (the highest point of the neck).
When looking to enter a long position, some traders wait for confirmation of the downtrend rather than simply generating an order after the price breaks the flag support line and continues lower. This can help avoid false signals and possible losses.
A stop-loss order can be used to try to limit losses if the price begins to move in the opposite direction. Typically, traders can open a stop-loss order above the flag resistance line.
A practical example
Suppose you are trading ETH/USDT on the daily chart and notice that a bearish flag pattern is forming. The bottom line of the flag is at $2,500 and the top line is at $2,800.
Let's say that, as a conservative trader, you decide to set your profit target using the distance between the parallel trend lines of the flag. In this case, the difference between the two lines is $300, so you add this amount to the price at the resistance breakout entry point, which is at $2,400.
Therefore, your price target is $2,700.
To manage your risk, you can place a stop-loss order above the flag resistance line; say, around $2,900. If the price moves in the opposite direction, your stop-loss order will be activated and limit potential losses.
Flags vs. pennants
It is not uncommon for traders to confuse flag patterns with pennants, another type of continuation pattern that suggests the likelihood of the trend continuing after consolidation.
Like flags, pennants also include a flagpole. While the flags present a consolidation phase with a rectangular shape, the pennants form a triangular figure with two converging lines that create the consolidation period.
Use bullish and bearish flags with caution
Bullish and bearish flags can serve as valuable tools in technical analysis to determine target prices in trending markets. However, they do not guarantee the projected return, as false resistance breaks may occur. A false resistance breakout happens when a crypto asset crosses the critical flag boundary, but then quickly retraces.
Traders must first identify if a consistent trend exists. This could be in the form of a bull flag that appears in a market with increasing interest or a bear flag that forms in a trend with weakening momentum. Volume is also key, as a resistance break is usually accompanied by strong moves.
Keep in mind that traders often use several indicators together. The Relative Strength Index (RSI) is typically used with bullish and bearish flags to measure how overbought or oversold a crypto asset is.
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